Baidu (NASDAQ:BIDU) recently authorized a buyback of up to $1 billion in shares over the next 12 months. The buyback, which will be funded with the company's existing cash, could reduce Baidu's float by about 1% based on its current market cap of $85 billion.

The decision wasn't surprising -- Baidu significantly boosted its cash flow with its spinoff of iQiyi earlier this year. However, the timing also coincides with Baidu's potential offering of CDRs (Chinese Depositary Receipts). I'll explain why these two events could be related.

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What are CDRs?

Many Chinese tech giants, including Baidu and Alibaba (NYSE:BABA), made their public debuts on American exchanges because the approval process was simpler and shorter than the process for Chinese exchanges, which require companies to post several years of profits before going public in the domestic "A-shares" market.

Chinese regulators also ban direct foreign investments in certain industries, like internet- and education-related companies. To sidestep that rule, many Chinese tech companies use a corporate structure called a "VIE" (variable interest entity). In this setup, foreign investors invest in an offshore company that is owned by Chinese nationals. The offshore company, in turn, owns an equity stake in the Chinese tech company.

When American investors buy ADR (American Depositary Receipts) in Baidu and Alibaba, they are technically buying shares of holding companies in the Cayman Islands. But in recent years, mainland Chinese investors noticed that VIEs prevented them from profiting from the growth of top Chinese tech companies.

To address that issue, Chinese exchanges introduced CDRs, which duplicate the concept of ADRs for Chinese investors. Chinese investors would also hold shares of a holding company instead of the actual company, but the CDRs would be more easily approved for the domestic A-shares market.

Why does this matter to Baidu?

On June 25, Baidu disclosed that it was "evaluating a potential offering and listing" of CDRs. It also warned that if the offering was approved, its total outstanding shares would increase, as "any CDR offered will represent newly issued Class A ordinary shares of Baidu."

Simply put, Baidu's CDRs would dilute the value of Baidu's existing ADRs. Baidu didn't offer any additional details, like the size or the date of the offering. However, Baidu's abrupt decision to repurchase $1 billion in shares could match the size of its upcoming offering.

If Baidu really uses a buyback to offset its expected dilution from CDRs, it would be a puzzling decision; the company could merely be spending its proceeds from a CDR offering to offset the dilution in its ADRs. However, it would make sense if the Chinese government -- tired of watching American investors profit from Baidu's growth -- is pressuring the company to offer CDRs.

Shanghai at night.

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Caixin reported that market regulators were pushing leading tech companies to offer CDRs, and Bloomberg recently claimed that bringing Baidu and Alibaba back to domestic exchanges could "burnish the reputation of China's twin bourses in Shanghai and Shenzhen, notorious for spotty regulation, volatility, and periodic government intervention."

However, regulatory pressure could still have its limits. Xiaomi, which was widely expected to launch the first CDR, recently postponed its mainland Chinese offering while moving ahead with the listing of its "H-shares" in Hong Kong.

The key takeaway

A billion dollar buyback plan is usually good news for a company, but the unclear terms of Baidu's potential CDR offering raise tough questions about its intentions. If Baidu offers too many CDRs in a bid to please regulators, current ADR shareholders could be left with diluted shares at a higher valuation.

 

Leo Sun owns shares of Baidu. The Motley Fool owns shares of and recommends Baidu. The Motley Fool recommends iQiyi. The Motley Fool has a disclosure policy.